NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Graco Inc. and Subsidiaries
Years Ended December 30, 2022, December 31, 2021 and December 25, 2020
A. Summary of Significant Accounting Policies
Fiscal Year. The fiscal year of Graco Inc. and Subsidiaries (the “Company”) is 52 or 53 weeks, ending on the last Friday in December. The year ended December 31, 2021 was a 53-week year whereas the years ended December 30, 2022 and December 25, 2020 were 52-week years.
Basis of Statement Presentation. The consolidated financial statements include the accounts of the parent company and its subsidiaries after elimination of intercompany balances and transactions. As of December 30, 2022, all subsidiaries are 100 percent controlled by the Company.
Foreign Currency Translation. The functional currency of certain subsidiaries is the local currency. Accordingly, adjustments resulting from the translation of those subsidiaries’ financial statements into U.S. dollars are charged or credited to accumulated other comprehensive income (loss). The U.S. dollar is the functional currency for all other foreign subsidiaries. Accordingly, gains and losses from the translation of foreign currency balances and transactions of those subsidiaries are included in other expense, net.
Accounting Estimates. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Such estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fair Value Measurements. The three levels of inputs in the fair value measurement hierarchy are as follows:
Level 1 – based on quoted prices in active markets for identical assets
Level 2 – based on significant observable inputs
Level 3 – based on significant unobservable inputs
Assets and liabilities measured at fair value on a recurring basis and fair value measurement level were as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| Level | | 2022 | | 2021 |
Assets | | | | | |
Cash surrender value of life insurance | 2 | | $ | 19,192 | | | $ | 23,147 | |
| | | | | |
| | | | | |
Liabilities | | | | | |
Contingent consideration | 3 | | $ | 14,914 | | | $ | 12,274 | |
Deferred compensation | 2 | | 5,842 | | | 5,962 | |
Forward exchange contracts | 2 | | 520 | | | 111 | |
Total liabilities at fair value | | | $ | 21,276 | | | $ | 18,347 | |
Contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans are held in trust. Cash surrender value of the contracts is based on performance measurement funds that shadow the deferral investment allocations made by participants in certain deferred compensation plans. The deferred compensation liability balances are valued based on amounts allocated by participants to the underlying performance measurement funds.
The Company’s policy and accounting for forward exchange contracts are described below, in Derivative Instruments and Hedging Activities.
Contingent consideration liability represents the estimated value (using a probability-weighted expected return approach) of future payments to be made to previous owners of certain acquired businesses based on future revenues.
Disclosures related to other fair value measurements are included below in Impairment of Long-Lived Assets, in Note F (Debt) and in Note J (Retirement Benefits).
Cash Equivalents. All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents.
Accounts Receivable. Accounts receivable includes trade receivables of $334 million in 2022 and $315 million in 2021. Other receivables totaled $12 million in 2022 and $10 million in 2021.
Allowance for Credit Losses. Receivables reflected in the financial statements represent the net amount expected to be collected. An allowance for credit losses is established based on expected losses. Expected losses are estimated by reviewing individual accounts, considering aging, financial condition of the debtor, recent payment history, current and forecast economic conditions and other relevant factors.
Following is a summary of activity in the allowance for credit losses (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | | | 2022 | | 2021 | | 2020 |
Balance, beginning | | | | $ | 3,254 | | | $ | 3,745 | | | $ | 4,828 | |
Additions (reversals) charged to costs and expenses | | | | 3,567 | | | (27) | | | 647 | |
Deductions from reserves (1) | | | | (633) | | | (676) | | | (2,732) | |
Other additions (deductions) (2) | | | | (58) | | | 212 | | | 1,002 | |
Balance, ending | | | | $ | 6,130 | | | $ | 3,254 | | | $ | 3,745 | |
(1) Represents amounts determined to be uncollectible and charged against reserves, net of collections on accounts previously charged against reserves.
(2) Includes effects of foreign currency translation.
Inventory Valuation. Inventories are stated at the lower of cost or net realizable value. The last-in, first-out (LIFO) cost method is used for valuing most U.S. inventories. Inventories of foreign subsidiaries are valued using the first-in, first-out (FIFO) cost method.
Other Current Assets. Amounts included in other current assets were (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Prepaid income taxes | $ | 18,702 | | | $ | 10,485 | |
| | | |
Prepaid expenses and other | 24,922 | | | 21,401 | |
Total | $ | 43,624 | | | $ | 31,886 | |
Impairment of Long-Lived Assets. The Company evaluates long-lived assets (including property and equipment, goodwill and other intangible assets) for impairment annually in the fourth quarter, or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
We completed our annual impairment test of all long-lived assets in the fourth quarter of 2022. No impairment charges were recorded as a result of that review. In connection with the Company's sale of its U.K.-based valve business in 2020, impairment charges of $35 million were recorded. There were no additional impairment charges in 2021 or 2020.
Property, Plant and Equipment. For financial reporting purposes, plant and equipment are depreciated over their estimated useful lives, primarily by using the straight-line method as follows:
| | | | | | | | |
Buildings and improvements | | 10 to 30 years |
Leasehold improvements | | lesser of 5 to 10 years or life of lease |
Manufacturing equipment | | lesser of 5 to 10 years or life of equipment |
Office, warehouse and automotive equipment | | 3 to 10 years |
Goodwill and Other Intangible Assets. Goodwill has been assigned to reporting units. Changes in the carrying amounts of goodwill for each reportable segment were (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Industrial | | Process | | Contractor | | Total |
Balance, December 25, 2020 | $ | 140,997 | | | $ | 141,513 | | | $ | 65,093 | | | $ | 347,603 | |
Additions, adjustments from business acquisitions | — | | | — | | | 13,321 | | | 13,321 | |
| | | | | | | |
Foreign currency translation | (3,842) | | | (209) | | | (618) | | | (4,669) | |
Balance, December 31, 2021 | 137,155 | | | 141,304 | | | 77,796 | | | 356,255 | |
Additions, adjustments from business acquisitions | — | | | 16,994 | | | — | | | 16,994 | |
Foreign currency translation | (2,384) | | | (1,932) | | | (762) | | | (5,078) | |
Balance, December 30, 2022 | $ | 134,771 | | | $ | 156,366 | | | $ | 77,034 | | | $ | 368,171 | |
Components of other intangible assets were (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Finite Life | | Indefinite Life | | |
| Customer Relationships | | Patents and Proprietary Technology | | Trademarks, Trade Names and Other | | Trade Names | | Total |
As of December 30, 2022 | | | | | | | | | |
Cost | $ | 202,103 | | | $ | 26,374 | | | $ | 1,300 | | | $ | 62,633 | | | $ | 292,410 | |
Accumulated amortization | (123,603) | | | (18,027) | | | (330) | | | — | | | (141,960) | |
Foreign currency translation | (10,060) | | | (894) | | | — | | | (1,989) | | | (12,943) | |
Book value | $ | 68,440 | | | $ | 7,453 | | | $ | 970 | | | $ | 60,644 | | | $ | 137,507 | |
Weighted average life in years | 13 | | 10 | | 6 | | N/A | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
As of December 31, 2021 | | | | | | | | | |
Cost | $ | 194,505 | | | $ | 26,074 | | | $ | 900 | | | $ | 62,633 | | | $ | 284,112 | |
Accumulated amortization | (108,657) | | | (15,734) | | | (452) | | | — | | | (124,843) | |
Foreign currency translation | (7,710) | | | (707) | | | — | | | (1,112) | | | (9,529) | |
Book value | $ | 78,138 | | | $ | 9,633 | | | $ | 448 | | | $ | 61,521 | | | $ | 149,740 | |
Weighted average life in years | 13 | | 10 | | 5 | | N/A | | |
Amortization of intangibles was $18.9 million in 2022, $17.9 million in 2021 and $16.7 million in 2020. Estimated future annual amortization expense based on the current carrying amount of other intangible assets is as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2023 | | 2024 | | 2025 | | 2026 | | 2027 | | Thereafter |
Estimated Amortization Expense | $ | 17,397 | | | $ | 16,169 | | | $ | 15,704 | | | $ | 8,972 | | | $ | 6,291 | | | $ | 12,330 | |
The Company completed business acquisitions in 2022, 2021 and 2020 that were not material to the consolidated financial statements.
Other Assets. Components of other assets were (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Cash surrender value of life insurance | $ | 19,192 | | | $ | 23,147 | |
Capitalized software | 2,189 | | | 2,394 | |
Equity method investment | 8,767 | | | 7,541 | |
| | | |
Deposits and other | 2,970 | | | 3,607 | |
Total | $ | 33,118 | | | $ | 36,689 | |
The Company has entered into contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans. These insurance contracts are used to fund the non-qualified pension and deferred compensation arrangements. The insurance contracts are held in a trust and are available to general creditors in the event of the Company’s insolvency. Changes in cash surrender value are recorded in other expense, net. The cash surrender value decreased $4.0 million in 2022, and increased $3.3 million in 2021 and $2.2 million in 2020.
Capitalized software is amortized over its estimated useful life (generally 2 to 5 years) beginning at date of implementation.
Other Current Liabilities. Components of other current liabilities were (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Accrued self-insurance retentions | $ | 9,338 | | | $ | 9,303 | |
Accrued warranty and service liabilities | 14,674 | | | 14,463 | |
Accrued trade promotions | 13,799 | | | 15,872 | |
Payable for employee stock purchases | 16,497 | | | 15,746 | |
Customer advances and deferred revenue | 50,747 | | | 60,554 | |
Income taxes payable | 15,987 | | | 5,200 | |
Tax payable, other | 9,614 | | | 8,295 | |
Operating lease liabilities, current | 9,555 | | | 9,096 | |
Right of return refund liability | 18,449 | | | 18,614 | |
Other | 32,133 | | | 34,016 | |
Total | $ | 190,793 | | | $ | 191,159 | |
Self-Insurance. The Company is self-insured for certain losses and costs relating to product liability, workers’ compensation, and employee medical benefit claims. The Company has stop-loss coverage in order to limit its exposure to significant claims. Accrued self-insurance retentions are based on claims filed, estimates of claims incurred but not reported, and other actuarial assumptions. Self-insured reserves totaled $9.3 million as of December 30, 2022 and December 31, 2021.
Product Warranties. A liability is established for estimated future warranty and service claims that relate to current and prior period sales. The Company estimates warranty costs based on historical claim experience and other factors including evaluating specific product warranty issues. Following is a summary of activity in accrued warranty and service liabilities (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Balance, beginning of year | $ | 14,463 | | | $ | 13,082 | |
Assumed in business acquisition | 38 | | | 23 | |
Charged to expense | 8,946 | | | 10,764 | |
Margin on parts sales reversed | 3,292 | | | 3,475 | |
Reductions for claims settled | (12,065) | | | (12,881) | |
Balance, end of year | $ | 14,674 | | | $ | 14,463 | |
Revenue Recognition. Revenue is recognized at a single point in time upon the satisfaction of performance obligations, which occurs when control of the good or service transfers to the customer. This is generally on the date of shipment; however certain sales have terms requiring recognition when received by the customer. In cases where there are specific customer acceptance provisions, revenue is recognized at the later of customer acceptance or shipment (subject to shipping terms). Payment terms are established based on the type of product, distributor capabilities and competitive market conditions, and do not exceed one year. Standalone selling prices are determined based on the prices charged to customers for all material performance obligations.
Variable consideration is accounted for as a price adjustment (sales adjustment). Following are examples of variable consideration that affect the Company’s reported revenue. Early payment discounts are provided to certain customers and within certain regions. Rights of return are typically contractually limited and amounts are estimable. The Company records a refund liability and establishes a recovery asset for the value of product expected to be returned at the time revenue is recognized. This includes promotions when, from time to time, the Company may promote the sale of new products by agreeing to accept returns of superseded products. Provisions for sales returns are recorded as a reduction of net sales, and provisions for warranty claims are recorded in selling, marketing and distribution expenses. Historically, sales returns have been approximately 3 percent of sales. Trade promotions are offered to distributors and end users through various programs, generally with terms of one year or less. Such promotions include rebates based on annual purchases and sales growth, coupons and reimbursement for competitive products. Payment of incentives may take the form of cash, trade credit, promotional merchandise or free product. Rebates are accrued based on the program rates and progress toward the probability weighted estimate of annual sales amount and sales growth.
Additional promotions include cooperative advertising arrangements. Under cooperative advertising arrangements, the Company reimburses the distributor for a portion of its advertising costs related to the Company’s products. Estimated costs are accrued at the time of sale and classified as selling, marketing and distribution expense. The estimated costs related to coupon programs are accrued at the time of sale and classified as selling, marketing and distribution expense or cost of products sold, depending on the type of incentive offered. The considerations payable to customers are deemed as broad based and are not recorded against net sales.
Shipping and handling costs incurred for the delivery of goods to customers are included in cost of goods sold. Amounts billed to customers for shipping and handling are included in net sales.
Revenue is deferred when cash payments are received or due in advance of performance, including amounts which are refundable. This is also the case for services associated with certain product sales. The balance in the deferred revenue and customer advances was $50.7 million as of December 30, 2022 and $60.6 million as of December 31, 2021. Net sales for 2022 included $60.4 million that was in deferred revenue and customer advances as of December 31, 2021. Net sales for 2021 included $40.9 million that was in deferred revenue and customer advances as of December 25, 2020.
Shipping and handling activities that occur after control of the related good transfers are accounted for as fulfillment activities instead of assessing such activities as performance obligations.
Sales taxes related to revenue producing transactions collected from the customer for a governmental authority are excluded from the transaction price.
Revenue standard requirements are applied to a portfolio of contracts (or performance obligations) with similar characteristics for transactions where it is expected that the effects on the financial statements of applying the revenue recognition guidance to the portfolio would not differ materially from applying this guidance to the individual contracts (or performance obligations) within that portfolio.
Promised goods or services are not assessed as performance obligations if they are immaterial in the context of the contract with the customer. If the revenue related to a performance obligation that includes goods or services that are immaterial in the context of the contract is recognized before those immaterial goods or services are transferred to the customer, then the related costs to transfer those goods or services are accrued.
Incremental costs of obtaining a contract are generally expensed when incurred because the amortization period would be less than one year. Such costs primarily relate to sales commissions and are recorded in selling, marketing and distribution expense.
Earnings Per Common Share. Basic net earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the year. Diluted net earnings per share is computed after giving effect to the exercise of all dilutive outstanding option grants.
Comprehensive Income. Comprehensive income is a measure of all changes in shareholders’ equity except those resulting from investments by and distributions to owners, and includes such items as net earnings, certain foreign currency translation items, changes in the value of qualifying hedges and pension liability adjustments.
Derivative Instruments and Hedging Activities. The Company accounts for all derivatives, including those embedded in other contracts, as either assets or liabilities and measures those financial instruments at fair value. The accounting for changes in the fair value of derivatives depends on their intended use and designation.
As part of its risk management program, the Company may periodically use forward exchange contracts to manage known market exposures. Terms of derivative instruments are structured to match the terms of the risk being managed and are generally held to maturity. The Company does not hold or issue derivative financial instruments for trading purposes. All other contracts that contain provisions meeting the definition of a derivative also meet the requirements of, and have been designated as, normal purchases or sales. The Company’s policy is to not enter into contracts with terms that cannot be designated as normal purchases or sales.
The Company periodically evaluates its monetary asset and liability positions denominated in foreign currencies. The Company enters into forward contracts or options, or borrows in various currencies, in order to hedge its net monetary positions. These instruments are recorded at fair value and the gains and losses are included in other expense, net. The notional amounts of contracts outstanding as of December 30, 2022, totaled $48 million. The Company believes it uses strong financial counterparties in these transactions and that the resulting credit risk under these hedging strategies is not significant.
The Company uses significant other observable inputs (level 2 in the fair value hierarchy) to value the derivative instruments used to hedge net monetary positions, including reference to market prices and financial models that incorporate relevant market assumptions. Net derivative assets are reported on the balance sheet in accounts receivable and net derivative liabilities are reported as other current liabilities. The fair market value of such instruments follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Foreign Currency Contracts | | | |
Assets | $ | 157 | | | $ | 239 | |
Liabilities | (677) | | | (350) | |
Net Assets (Liabilities) | $ | (520) | | | $ | (111) | |
B. Segment Information
The Company has five operating segments which are aggregated into three reportable segments: Contractor, Industrial and Process.
Beginning with the first quarter of 2022, our high performance coatings and foam product offerings previously included within the Applied Fluid Technologies division of the Industrial segment were realigned and are now managed under the Contractor segment. This change aligns the types of products offered and markets served within the segments. Prior year segment information has been restated to conform to the current organizational structure.
The Contractor segment markets sprayers and equipment that apply paint to walls and other structures, texture to walls and ceilings, insulation to building walls and other items, highly viscous coatings to roofs, and markings on roads, parking lots, athletic fields and floors.
The Industrial segment includes our Industrial and Powder divisions. The Industrial segment markets equipment and solutions for moving and applying paints, coatings, sealants, adhesives and other fluids. Markets served include automotive and vehicle assembly and components production, wood and metal products, rail, marine, aerospace, farm, construction, bus, recreational vehicles and various other industries.
The Process segment includes our Process and Lubrication divisions. The Process segment markets pumps, valves, meters and accessories to move and dispense chemicals, oil and natural gas, water, wastewater, petroleum, food,
lubricants and other fluids. Markets served include food and beverage, dairy, oil and natural gas, pharmaceutical, cosmetics, electronics, semiconductor fabrication, wastewater, mining, fast oil change facilities, service garages, fleet service centers, automobile dealerships and industrial lubrication applications.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The cost of manufacturing for each segment is based on product cost, and expenses are based on actual costs incurred along with cost allocations of shared and centralized functions based on activities performed, sales or space utilization. Depreciation expense is charged to the manufacturing or operating cost center that utilizes the asset, and is then allocated to segments on the same basis as other expenses within that cost center. Reportable segments are defined by product. Segments are responsible for development, manufacturing, marketing and sales of their products. This allows for focused marketing and efficient product development. The segments share common purchasing, certain manufacturing, distribution and administration functions.
Segment information follows (in thousands):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Net Sales | | | | | |
Contractor | $ | 999,060 | | | $ | 987,606 | | | $ | 842,525 | |
Industrial | 649,347 | | | 602,376 | | | 481,485 | |
Process | 495,114 | | | 397,626 | | | 326,105 | |
Total | $ | 2,143,521 | | | $ | 1,987,608 | | | $ | 1,650,115 | |
Operating Earnings | | | | | |
Contractor | $ | 249,833 | | | $ | 266,204 | | | $ | 243,185 | |
Industrial | 231,298 | | | 199,856 | | | 147,939 | |
Process | 122,344 | | | 91,037 | | | 64,498 | |
Unallocated corporate (expense) | (30,775) | | | (25,774) | | | (28,675) | |
Impairment | — | | | — | | | (35,229) | |
Total | $ | 572,700 | | | $ | 531,323 | | | $ | 391,718 | |
Assets | | | | | |
Contractor | $ | 752,729 | | | $ | 656,998 | | | |
Industrial | 578,302 | | | 544,585 | | | |
Process | 564,539 | | | 436,189 | | | |
Unallocated corporate | 543,330 | | | 805,426 | | | |
Total | $ | 2,438,900 | | | $ | 2,443,198 | | | |
Management assesses performance of segments by reference to operating earnings excluding unallocated corporate expenses and asset impairments. Unallocated corporate (expense) includes such items as stock compensation, certain acquisition transaction costs, bad debt expense, charitable contributions and certain facility expenses. Unallocated assets include cash, allowances and valuation reserves, deferred income taxes, certain capital and other assets.
Geographic information follows (in thousands):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Net Sales (based on customer location) | | | | | |
United States | $ | 1,116,012 | | | $ | 1,004,318 | | | $ | 883,451 | |
Other countries | 1,027,509 | | | 983,290 | | | 766,664 | |
Total | $ | 2,143,521 | | | $ | 1,987,608 | | | $ | 1,650,115 | |
Long-lived Assets | | | | | |
United States | $ | 532,401 | | | $ | 388,835 | | | |
Other countries | 75,208 | | | 62,226 | | | |
Total | $ | 607,609 | | | $ | 451,061 | | | |
Sales to Major Customers. Worldwide sales to one customer in the Contractor and Industrial segments individually represented over 10 percent of the Company’s consolidated sales in 2022, 2021 and 2020.
C. Inventories
Major components of inventories were as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Finished products and components | $ | 222,326 | | | $ | 166,922 | |
Products and components in various stages of completion | 138,957 | | | 117,063 | |
Raw materials and purchased components | 248,636 | | | 185,291 | |
Subtotal | 609,919 | | | 469,276 | |
Reduction to LIFO cost | (133,129) | | | (86,975) | |
Total | $ | 476,790 | | | $ | 382,301 | |
Inventories valued under the LIFO method were $253.6 million in 2022 and $211.1 million in 2021. All other inventory was valued on the FIFO method.
D. Property, Plant and Equipment
Property, plant and equipment were as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Land and improvements | $ | 65,066 | | | $ | 42,195 | |
Buildings and improvements | 376,115 | | | 280,947 | |
Manufacturing equipment | 439,109 | | | 384,617 | |
Office, warehouse and automotive equipment | 59,988 | | | 61,994 | |
Additions in progress | 126,198 | | | 105,520 | |
Total property, plant and equipment | 1,066,476 | | | 875,273 | |
Accumulated depreciation | (458,867) | | | (424,212) | |
Net property, plant and equipment | $ | 607,609 | | | $ | 451,061 | |
Depreciation expense was $46.0 million in 2022, $40.0 million in 2021 and $38.0 million in 2020.
E. Income Taxes
Earnings before income tax expense consist of (in thousands):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Domestic | $ | 401,405 | | | $ | 370,903 | | | $ | 289,708 | |
Foreign | 164,319 | | | 137,562 | | | 84,943 | |
Total | $ | 565,724 | | | $ | 508,465 | | | $ | 374,651 | |
Income tax expense consists of (in thousands):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Current | | | | | |
Federal | $ | 70,976 | | | $ | 77,703 | | | $ | 11,509 | |
State and local | 5,948 | | | 7,493 | | | 3,217 | |
Foreign | 38,152 | | | 29,975 | | | 18,722 | |
Current income tax expense | 115,076 | | | 115,171 | | | 33,448 | |
Deferred | | | | | |
Domestic | (8,733) | | | (42,413) | | | 12,856 | |
Foreign | (1,264) | | | (4,159) | | | (2,109) | |
Deferred income tax expense (benefit) | (9,997) | | | (46,572) | | | 10,747 | |
Total | $ | 105,079 | | | $ | 68,599 | | | $ | 44,195 | |
Income taxes paid were $112.3 million in 2022, $111.8 million in 2021 and $44.0 million in 2020.
A reconciliation between the U.S. federal statutory tax rate and the effective tax rate follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Statutory tax rate | 21 | % | | 21 | % | | 21 | % |
Tax effect of international operations | 1 | | | (1) | | | (2) | |
State taxes, net of federal effect | 1 | | | 1 | | | 1 | |
U.S. general business tax credits | (1) | | | (1) | | | (1) | |
Loss on sale of business | — | | | — | | | 2 | |
Stock compensation excess tax benefit | (1) | | | (2) | | | (6) | |
| | | | | |
| | | | | |
| | | | | |
Foreign Derived Intangible Income (FDII) | (2) | | | (5) | | | (3) | |
| | | | | |
Effective tax rate | 19 | % | | 13 | % | | 12 | % |
Deferred income taxes are provided for temporary differences between the financial reporting and the tax basis of assets and liabilities. The deferred tax assets (liabilities) resulting from these differences were as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Inventory valuations | $ | 678 | | | $ | 1,181 | |
Accrued self-insurance retentions | 1,626 | | | 1,534 | |
Accrued warranty and service liabilities | 2,279 | | | 2,285 | |
Vacation accruals | 3,409 | | | 3,261 | |
Customer allowances | 4,143 | | | 4,028 | |
Excess of tax over book depreciation and amortization | (42,322) | | | (39,785) | |
Pension benefit obligation | 6,375 | | | 16,022 | |
Postretirement medical benefit obligation | 5,072 | | | 5,028 | |
| | | |
Stock compensation | 12,390 | | | 11,442 | |
Deferred compensation | 2,283 | | | 2,595 | |
| | | |
Deferred revenue | 2,160 | | | 2,427 | |
| | | |
Research and Development | 11,370 | | | — | |
Prepayments from foreign subsidiaries | 36,070 | | | 32,969 | |
Other | 2,114 | | | 2,138 | |
Net deferred tax assets | $ | 47,647 | | | $ | 45,125 | |
Total deferred tax assets were $57.1 million and $55.8 million, and total deferred tax liabilities were $9.4 million and $10.7 million on December 30, 2022 and December 31, 2021, respectively. The difference between the deferred income tax provision and the change in net deferred income taxes is due to the changes in other comprehensive income (loss) items and acquisition purchase accounting.
The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2016.
The Company continues to assert that it will indefinitely reinvest earnings of foreign subsidiaries to support expansion of its international business. No additional income or withholding taxes have been provided for any remaining undistributed foreign earnings, as these amounts continue to be indefinitely reinvested in foreign operations. As of December 30, 2022, the amount of cash held outside the U.S. was not significant to the Company’s liquidity and was available to fund investments abroad.
The Company records penalties and accrued interest related to uncertain tax positions in income tax expense. Total reserves for uncertain tax positions were not material.
F. Debt
A summary of debt follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Average Interest Rate | | | | | | |
| December 30, 2022 | | Maturity | | 2022 | | 2021 |
Private placement unsecured fixed-rate notes | | | | | | | |
Series B | 5.01% | | January 2022 | | — | | | 75,000 | |
| | | | | | | |
Series D | 5.35% | | July 2026 | | 75,000 | | | 75,000 | |
Unsecured revolving credit facility | N/A | | March 2026 | | — | | | — | |
Unsecured revolving credit facility - offshore renminbi denominated | 3.34% | | N/A | | 14,327 | | | 39,222 | |
Notes payable to banks | 2.80% | | 2023 | | 6,647 | | | 4,267 | |
Total debt | | | | | $ | 95,974 | | | $ | 193,489 | |
The estimated fair value of the fixed interest rate private placement debt was $75 million on December 30, 2022 and $165 million on December 31, 2021. The fair value of variable rate borrowings approximates carrying value. The Company uses significant other observable inputs to estimate fair value (level 2 of the fair value hierarchy) based on the present value of future cash flows and rates that would be available for issuance of debt with similar terms and remaining maturities.
On March 25, 2021, the Company entered into an amended and restated credit agreement that amends, supersedes and restates in its entirety the Company's prior credit agreement with U.S. Bank National Association, as administrative agent (the “Agent”) and a lender, and the other lenders that are parties thereto. The amended and restated credit agreement extends the maturity of the Company’s $500 million unsecured revolving credit facility from December 15, 2021 to March 25, 2026; includes a $250 million accordion feature; and provides mechanisms for two further one-year extensions of the maturity, subject to the consent of the extending banks.
Borrowings under the amended and restated credit agreement may be denominated in U.S. dollars or certain other currencies. Outstanding loans in currencies other than U.S. dollars cannot exceed $200 million in the aggregate. The amended and restated credit agreement contains customary provisions for the replacement of the LIBOR-based rate as that rate is expected to be phased out by July 1, 2023. Currently, loans denominated in U.S. dollars may bear interest, at the Company’s option, at either a base rate or a LIBOR-based rate. Loans denominated in currencies other than U.S. dollars will bear interest at a LIBOR-based rate. The base rate is an annual rate equal to a margin ranging from 0.00% to 0.75%, depending on the Company’s cash flow leverage ratio, plus the highest of (i) the rate of interest from time to time announced by the Agent as its prime rate, (ii) the federal funds effective rate plus 0.50%, or (iii) one-month LIBOR plus 1.50%. In general, LIBOR-based loans bear interest at a rate per annum equal to LIBOR, plus a margin ranging from 1.00% to 1.75%, depending on the Company’s cash flow leverage ratio. In addition to paying interest on the outstanding loans, the Company is required to pay a facility fee on the unused amount of the loan commitments at a rate per annum ranging from 0.125% to 0.25%, depending on the Company’s cash flow leverage ratio.
The amended and restated credit agreement contains customary representations, warranties, covenants and events of default, including but not limited to covenants restricting the Company’s and its subsidiaries’ ability to (i) merge or
consolidate with another entity, (ii) sell, transfer, lease or convey their assets, (iii) make any material change in the nature of the core business of the Company, (iv) make certain investments, or (v) incur secured indebtedness. The amended and restated credit agreement also requires the Company to maintain a cash flow leverage ratio of not more than 3.50 to 1.00 (unless a significant acquisition has been consummated, in which case, not more than 4.00 to 1.00 during the four fiscal quarter period beginning with the quarter in which such acquisition occurs) and an interest coverage ratio of not less than 3.00 to 1.00 (unless a significant acquisition has been consummated, in which case, not less than 2.50 to 1.00 during the four fiscal quarter period beginning with the quarter in which such acquisition occurs). A change in control of the Company will constitute an event of default under the amended and restated credit agreement.
The Company maintains a revolving credit agreement with a sole lender that provides up to $50 million of committed credit, available for general corporate purposes, working capital needs, share repurchases and acquisitions. Under the terms of the agreement, loans may be denominated in U.S. dollars or Chinese renminbi (offshore). Loans denominated in U.S. dollars bear interest, at the Company’s option, at either a base rate or a LIBOR-based rate. Loans denominated in Chinese renminbi (offshore) bear interest at a LIBOR-based rate based on the Chinese offshore rate. Other terms of this revolving credit agreement are substantially similar to those of the Company’s amended and restated credit agreement that expires in March 2026.
On December 16, 2022, the Company entered into an amendment to its master note agreement that extends the period in which the Company may issue, and affiliates of the lender may purchase, the Company’s senior notes from January 29, 2023 to December 16, 2027. The amendment also increases the maximum aggregate principal amount of senior notes the Company may issue under the master note agreement from $200 million to $250 million, although the maximum aggregate amount of senior notes bearing interest at a floating rate that may be outstanding at any one time will continue to be $100 million. The amendment also extends the maturity and average life of each senior note bearing interest at a fixed rate that may be issued under the master note agreement from no more than 12 years after the date of issuance to no more than 15 years after the date of issuance, and includes customary provisions for the replacement of LIBOR with SOFR and customary benchmark replacement provisions with respect to senior notes bearing interest at a floating rate. All other material items of the master note agreement remain unchanged. Under the terms of the master note agreement, the Company is required to maintain certain financial ratios as to cash flow leverage and interest coverage similar to the requirements of its other debt agreements.
On December 30, 2022, the Company had $591 million in lines of credit, including the $550 million in committed credit facilities described above and $41 million with foreign banks. The unused portion of committed credit lines was $545 million as of December 30, 2022. In addition, the Company has unused, uncommitted lines of credit with foreign banks totaling $17 million. Borrowing rates under these credit lines vary with the prime rate, rates on domestic certificates of deposit and the London Interbank market. The Company pays facility fees at an annual rate of up to 0.15 on certain of these lines. No compensating balances are required.
Various debt agreements require the Company to maintain certain financial ratios as to cash flow leverage and interest coverage. The Company is in compliance with all financial covenants of its debt agreements as of December 30, 2022.
Annual maturities of debt are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2023 | | 2024 | | 2025 | | 2026 | | 2027 | | Thereafter |
Maturities of debt | $ | 20,974 | | | $ | — | | | $ | — | | | $ | 75,000 | | | $ | — | | | $ | — | |
Interest paid on debt was $10.0 million in 2022, $9.8 million in 2021 and $11.3 million in 2020.
In January 2022, we repaid $75 million of our Series B private placement note in addition to a $3.5 million prepayment fee, which was recognized as interest expense.
G. Shareholders’ Equity
At December 30, 2022, the Company had 22,549 authorized, but not issued, cumulative preferred shares, $100 par value. The Company also has authorized, but not issued, a separate class of 3 million shares of preferred stock, $1 par value.
Changes in components of accumulated other comprehensive income (loss), net of tax were (in thousands):
| | | | | | | | | | | | | | | | | |
| Pension and Postretirement Medical | | Cumulative Translation Adjustment | | Total |
Balance, December 27, 2019 | $ | (113,721) | | | $ | (56,066) | | | $ | (169,787) | |
Other comprehensive income (loss) before reclassifications | (7,852) | | | 46,030 | | | 38,178 | |
Amounts reclassified from accumulated other comprehensive income | 7,444 | | | — | | | 7,444 | |
| | | | | |
Balance, December 25, 2020 | (114,129) | | | (10,036) | | | (124,165) | |
Other comprehensive income (loss) before reclassifications | 34,953 | | | (10,026) | | | 24,927 | |
Amounts reclassified from accumulated other comprehensive income | 19,069 | | | — | | | 19,069 | |
Balance, December 31, 2021 | (60,107) | | | (20,062) | | | (80,169) | |
Other comprehensive income (loss) before reclassifications | 16,083 | | | (9,582) | | | 6,501 | |
Amounts reclassified from accumulated other comprehensive income | 4,290 | | | — | | | 4,290 | |
Balance, December 30, 2022 | $ | (39,734) | | | $ | (29,644) | | | $ | (69,378) | |
In connection with the Company's sale of its U.K.-based valve business in 2020, $24 million of unrealized foreign currency translation losses recorded in accumulated other comprehensive income were reclassified to net earnings.
Amounts related to pension and postretirement medical adjustments are classified to non-service components of pension cost that are included within other non-operating expenses. Included in the 2021 reclassification is $12 million related to a pension settlement loss. See Note J for additional details regarding pension and postretirement medical plans.
H. Share-Based Awards, Purchase Plans and Compensation Cost
Stock Option and Award Plan. The Company has a stock incentive plan under which it grants stock options and share awards to directors, officers and other employees. Option price is the market price on the date of grant. Options become exercisable at such time, generally over 3 years or 4 years, and in such installments as set by the Company, and expire 10 years from the date of grant.
Restricted share awards have been made to certain key employees under the plan. The market value of restricted stock at the date of grant is charged to operations over the vesting period. Compensation cost related to restricted shares is not significant.
The Company has a stock appreciation plan that provides for payments of cash to eligible foreign employees based on the change in the market price of the Company’s common stock over a period of time. Compensation cost related to the stock appreciation plan was a benefit of $0.2 million in 2022, and expense of $3.1 million in 2021 and $2.4 million in 2020.
Individual nonemployee directors of the Company may elect to receive, either currently or deferred, all or part of their retainer in the form of shares of the Company’s common stock instead of cash. Under this arrangement, the Company issued 12,055 shares in 2022, 12,070 shares in 2021 and 15,243 shares in 2020. The expense related to this arrangement is not significant.
Options on common shares granted and outstanding, as well as the weighted average exercise price, are shown below (in thousands, except exercise prices):
| | | | | | | | | | | | | | | | | | | | | | | |
| Option Shares | | Weighted Average Exercise Price | | Options Exercisable | | Weighted Average Exercise Price |
Outstanding, December 27, 2019 | 12,112 | | | $ | 28.91 | | | 8,231 | | | $ | 23.75 | |
Granted | 1,400 | | | 55.26 | | | | | |
Exercised | (3,238) | | | 20.81 | | | | | |
Canceled | (66) | | | 41.24 | | | | | |
Outstanding, December 25, 2020 | 10,208 | | | 35.02 | | | 6,553 | | | 28.02 | |
Granted | 843 | | | 72.22 | | | | | |
Exercised | (1,309) | | | 24.91 | | | | | |
Canceled | (167) | | | 55.59 | | | | | |
Outstanding, December 31, 2021 | 9,575 | | | 39.31 | | | 7,296 | | | 33.75 | |
Granted | 1,381 | | | 71.03 | | | | | |
Exercised | (645) | | | 25.58 | | | | | |
Canceled | (46) | | | 49.42 | | | | | |
Outstanding, December 30, 2022 | 10,265 | | | $ | 44.40 | | | 7,793 | | | $ | 37.22 | |
The following table summarizes information for options outstanding and exercisable at December 30, 2022 (in thousands, except exercise prices and contractual term amounts):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Options Outstanding | | Options Exercisable |
Range of Prices | | Options Outstanding | | Weighted Average Remaining Contractual Term in Years | | Weighted Average Exercise Price | | Options Exercisable | | Weighted Average Exercise Price |
$10 - $30 | | 2,971 | | | 2.4 | | $ | 24.76 | | | 2,971 | | | $ | 24.76 | |
$30 - $45 | | 2,317 | | | 4.7 | | 36.88 | | | 2,255 | | | 36.67 | |
$45 - $60 | | 2,813 | | | 6.6 | | 50.50 | | | 2,325 | | | 50.02 | |
$60 - $75 | | 2,164 | | | 9.0 | | 71.47 | | | 242 | | | 72.15 | |
$10 - $75 | | 10,265 | | | 5.5 | | $ | 44.40 | | | 7,793 | | | $ | 37.22 | |
The aggregate intrinsic value of exercisable option shares was $235.3 million as of December 30, 2022, with a weighted average contractual term of 4.5 years. There were approximately 10.3 million vested share options and share options expected to vest as of December 30, 2022, with an aggregate intrinsic value of $243.8 million, a weighted average exercise price of $44.40 and a weighted average contractual term of 5.5 years.
Information related to options exercised follows (in thousands):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Cash received | $ | 15,739 | | | $ | 32,610 | | | $ | 66,625 | |
Aggregate intrinsic value | 28,193 | | | 65,319 | | | 120,395 | |
Tax benefit realized | 6,020 | | | 13,329 | | | 25,000 | |
Employee Stock Purchase Plan. Under the Company’s Employee Stock Purchase Plan, the purchase price of the shares is the lesser of 85 percent of the fair market value on the first day or the last day of the plan year. Under this plan, the Company issued 316,250 shares in 2022, 415,995 shares in 2021 and 399,567 shares in 2020.
Authorized Shares. In April 2019, shareholders of the Company approved the Graco Inc. 2019 Stock Incentive Plan. The Plan provides for issuance of up to 10 million shares of Graco common stock. Shares authorized for issuance under the stock option and purchase plans are shown below (in thousands):
| | | | | | | | | | | |
| Total Shares Authorized | | Available for Future Issuance as of December 30, 2022 |
Stock Incentive Plan (2019) | 10,000 | | | 5,790 | |
Employee Stock Purchase Plan (2006) | 21,000 | | | 11,763 | |
Total | 31,000 | | | 17,553 | |
Amounts available for future issuance exclude outstanding options. Options outstanding as of December 30, 2022, include options granted under two plans that were replaced by subsequent plans. No shares are available for future grants under those plans.
Share-based Compensation. The Company recognized share-based compensation cost as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Share-based compensation | $ | 24,695 | | | $ | 24,931 | | | $ | 25,153 | |
Tax benefit | 2,319 | | | 1,705 | | | 1,700 | |
Share-based compensation, net of tax | $ | 22,376 | | | $ | 23,226 | | | $ | 23,453 | |
As of December 30, 2022, there was $17.4 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of approximately 2.7 years.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions and results:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Expected life in years | 6.4 | | 7.5 | | 7.5 |
Interest rate | 2.7 | % | | 0.9 | % | | 1.4 | % |
Volatility | 26.2 | % | | 25.2 | % | | 22.0 | % |
Dividend yield | 1.2 | % | | 1.0 | % | | 1.3 | % |
Weighted average fair value per share | $ | 19.10 | | | $ | 17.87 | | | $ | 12.18 | |
Expected life is estimated based on vesting terms and exercise and termination history. Interest rate is based on the U.S. Treasury rate on zero-coupon issues with a remaining term equal to the expected life of the option. Expected volatility is based on historical volatility over a period commensurate with the expected life of options.
The fair value of employees’ purchase rights under the Employee Stock Purchase Plan was estimated on the date of grant. The benefit of the 15 percent discount from the lesser of the fair market value per common share on the first day and the last day of the plan year was added to the fair value of the employees’ purchase rights determined using the Black-Scholes option-pricing model with the following assumptions and results:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Expected life in years | 1.0 | | 1.0 | | 1.0 |
Interest rate | 0.9 | % | | 0.1 | % | | 1.5 | % |
Volatility | 20.5 | % | | 40.1 | % | | 21.9 | % |
Dividend yield | 1.2 | % | | 1.1 | % | | 1.4 | % |
Weighted average fair value per share | $ | 16.01 | | | $ | 21.50 | | | $ | 11.55 | |
I. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Net earnings available to common shareholders | $ | 460,645 | | | $ | 439,866 | | | $ | 330,456 | |
Weighted average shares outstanding for basic earnings per share | 168,952 | | | 169,635 | | | 167,462 | |
Dilutive effect of stock options computed based on the treasury stock method using the average market price | 3,941 | | | 4,891 | | | 4,546 | |
Weighted average shares outstanding for diluted earnings per share | 172,893 | | | 174,526 | | | 172,008 | |
Basic earnings per share | $ | 2.73 | | | $ | 2.59 | | | $ | 1.97 | |
Diluted earnings per share | $ | 2.66 | | | $ | 2.52 | | | $ | 1.92 | |
Anti-dilutive stock options excluded from computations of diluted earnings per share totaled 2.2 million shares in 2022, 0.4 million shares in 2021 and 0.3 million 2020.
J. Retirement Benefits
The Company has a defined contribution plan, under Section 401(k) of the Internal Revenue Code, which provides retirement benefits to most U.S. employees. For all employees who choose to participate, the Company matches employee contributions at a 100 percent rate, up to 3 percent of the employee’s compensation. For employees not covered by a defined benefit plan, the Company contributed an amount equal to 2 percent of the employee’s compensation. Employer contributions totaled $11.0 million in 2022, $10.0 million in 2021 and $8.7 million in 2020.
The Company’s postretirement medical plan provides certain medical benefits for retired U.S. employees. Employees hired before January 1, 2005, are eligible for these benefits upon retirement and fulfillment of other eligibility requirements as specified by the plan.
The Company has both funded and unfunded noncontributory defined benefit pension plans that together cover most U.S. employees hired before January 1, 2006, certain directors and some of the employees of the Company’s non-U.S. subsidiaries. The Company restructured one of its U.S. qualified defined benefit plans in 2021. Under the restructuring, the plan transferred $63 million of liabilities and assets associated with certain plan participants to an insurance company via the purchase of a group annuity contract, and the Company recognized a $12 million settlement loss, included in 2021 other expense, net. This charge represents the acceleration of deferred charges previously accrued in accumulated other comprehensive income. Subsequent to the transfer of pension obligations, the smaller of the two pension plans was merged into the larger plan in December of 2021, with the larger plan being the surviving funded pension plan. The benefits offered to the plans’ participants were unchanged.
For U.S. plans, benefits are based on years of service and the highest 5 consecutive years’ earnings in the 10 years preceding retirement. Plans are funded annually in amounts consistent with minimum funding levels and maximum tax deduction limits, although the Company may make additional voluntary contributions from time to time to improve the funded status of its plans.
Investment policies and strategies of the U.S. funded pension plan are based on participant demographics. As the plan covers active participants and retirees with higher benefit amounts, investments are based on a long-term view of economic growth and weighted toward equity securities. The primary goal of the plan’s investments is to ensure that the plan’s liabilities are met over time. In developing strategic asset allocation guidelines, an emphasis is placed on the long-term characteristics of individual asset classes, and the benefits of diversification among multiple asset classes. The plan invests primarily in domestic and international equities, fixed income securities, which include treasuries, highly-rated corporate bonds and high-yield bonds and real estate. Strategic target allocations for plan assets are 53 percent equity securities, 42 percent fixed income securities and 5 percent real estate and alternative investments.
Plan assets are held in a trust for the benefit of plan participants and are invested in various commingled funds, most of which are sponsored by the trustee. The fair values for commingled equity, fixed-income and real estate investments are measured using net asset values, which take into consideration the value of underlying fund investments, as well as the other accrued assets and liabilities of a fund, in order to determine a per share market value. Certain trustee-sponsored
funds allow redemptions monthly or quarterly, with 10 days or 60 days advance notice, while most of the funds allow redemptions daily. The plan had unfunded commitments to make additional investments in certain funds totaling $2.3 million as of December 30, 2022 and $2.4 million as of December 31, 2021.
The Company maintains a defined contribution plan covering employees of a Swiss subsidiary, funded by Company and employee contributions. Responsibility for pension coverage under Swiss law has been transferred to a Swiss insurance company. Plan assets are invested in an insurance contract that guarantees a federally mandated annual rate of return. The value of the plan assets is effectively the value of the insurance contract. The performance of the underlying assets held by the insurance company has no direct impact on the surrender value of the insurance contract. The insurance backed assets have no active market and are classified as level 3 in the fair value hierarchy.
Assets of all plans by category and fair value measurement level were as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| Level | | 2022 | | 2021 |
Cash and cash equivalents | 1 | | $ | 351 | | | $ | 303 | |
Insurance contract | 3 | | 32,163 | | | 30,926 | |
Investments categorized in fair value hierarchy | | | 32,514 | | | 31,229 | |
Equity | | | | | |
U.S. Large Cap | N/A | | 74,838 | | | 110,569 | |
U.S. Small/Mid Cap | N/A | | 5,191 | | | 11,338 | |
International | N/A | | 37,862 | | | 56,128 | |
Total equity | | | 117,891 | | | 178,035 | |
Fixed income | N/A | | 93,262 | | | 130,774 | |
Real estate and other | N/A | | 37,508 | | | 7,862 | |
Investments measured at net asset value | | | 248,661 | | | 316,671 | |
Total | | | $ | 281,175 | | | $ | 347,900 | |
The following table is a reconciliation of pension assets measured at fair value using level 3 inputs (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Balance, beginning of year | $ | 30,926 | | | $ | 31,877 | |
Purchases | 2,431 | | | 2,430 | |
Redemptions | (669) | | | (2,556) | |
Unrealized losses | (525) | | | (825) | |
Balance, end of year | $ | 32,163 | | | $ | 30,926 | |
The following provides a reconciliation of the changes in the plans’ benefit obligations and fair value of assets over the periods ending December 30, 2022, and December 31, 2021, and a statement of the funded status as of the same dates (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Pension Benefits | | Postretirement Medical Benefits |
| 2022 | | 2021 | | 2022 | | 2021 |
Change in benefit obligation | | | | | | | |
Obligation, beginning of year | $ | 418,051 | | | $ | 510,652 | | | $ | 32,122 | | | $ | 34,458 | |
Service cost | 8,242 | | | 9,355 | | | 516 | | | 670 | |
Interest cost | 10,996 | | | 11,409 | | | 839 | | | 832 | |
Actuarial (gain) loss | (110,467) | | | (31,093) | | | (9,044) | | | (2,391) | |
Benefit payments | (9,122) | | | (13,360) | | | (1,503) | | | (1,447) | |
Plan amendments | (267) | | | (1,458) | | | — | | | — | |
Settlements | — | | | (64,886) | | | — | | | — | |
Exchange rate changes | (1,626) | | | (2,568) | | | — | | | — | |
Obligation, end of year | $ | 315,807 | | | $ | 418,051 | | | $ | 22,930 | | | $ | 32,122 | |
Change in plan assets | | | | | | | |
Fair value, beginning of year | $ | 347,900 | | | $ | 373,565 | | | $ | — | | | $ | — | |
Actual return on assets | (80,078) | | | 30,984 | | | — | | | — | |
Employer contributions | 22,756 | | | 22,493 | | | 1,503 | | | 1,447 | |
Benefit payments | (9,122) | | | (13,360) | | | (1,503) | | | (1,447) | |
Settlements | — | | | (64,886) | | | — | | | — | |
Exchange rate changes | (281) | | | (896) | | | — | | | — | |
Fair value, end of year | $ | 281,175 | | | $ | 347,900 | | | $ | — | | | $ | — | |
Unfunded status | $ | (34,632) | | | $ | (70,151) | | | $ | (22,930) | | | $ | (32,122) | |
| | | | | | | | | | | | | | | | | | | | | | | |
Amounts recognized in consolidated balance sheets | | | | | | | |
Non-current assets | $ | 5,398 | | | $ | — | | | $ | — | | | $ | — | |
Current liabilities | 1,860 | | | 1,769 | | | 1,763 | | | 1,768 | |
Non-current liabilities | 38,170 | | | 68,382 | | | 21,167 | | | 30,354 | |
Net | $ | 34,632 | | | $ | 70,151 | | | $ | 22,930 | | | $ | 32,122 | |
Changes in discount rates used to value pension obligations were the main drivers of actuarial gains in 2022 and 2021. In 2022 and 2021, the Company made a $20 million voluntary contribution each year to one of its U.S. qualified defined benefit plans.
The accumulated benefit obligation as of year-end for all defined benefit pension plans was $297 million for 2022 and $388 million for 2021. Information for plans with an accumulated benefit obligation in excess of plan assets follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Projected benefit obligation | $ | 72,190 | | | $ | 91,678 | |
Accumulated benefit obligation | 69,395 | | | 88,927 | |
Fair value of plan assets | 32,164 | | | 30,926 | |
The components of net periodic benefit cost for the plans for 2022, 2021 and 2020 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Pension Benefits | | Postretirement Medical Benefits |
| 2022 | | 2021 | | 2020 | | 2022 | | 2021 | | 2020 |
Service cost-benefits earned during the period | $ | 8,242 | | | $ | 9,355 | | | $ | 9,361 | | | $ | 516 | | | $ | 670 | | | $ | 609 | |
Interest cost on projected benefit obligation | 10,996 | | | 11,409 | | | 13,313 | | | 839 | | | 832 | | | 1,016 | |
Expected return on assets | (19,754) | | | (20,767) | | | (18,814) | | | — | | | — | | | — | |
Amortization of prior service cost | 84 | | | 246 | | | 294 | | | — | | | — | | | — | |
Amortization of net loss | 4,701 | | | 9,248 | | | 10,243 | | | 345 | | | 1,002 | | | 733 | |
Settlement loss | — | | | 12,285 | | | — | | | — | | | — | | | — | |
Cost of pension plans which are not significant and have not adopted ASC 715 | 284 | | | 368 | | | 168 | | | N/A | | N/A | | N/A |
Net periodic benefit cost | $ | 4,553 | | | $ | 22,144 | | | $ | 14,565 | | | $ | 1,700 | | | $ | 2,504 | | | $ | 2,358 | |
Net periodic benefit cost is disaggregated between service cost presented as operating expense and other components of pension cost presented as non-operating expense. Other components of pension cost and changes in cash surrender value of insurance contracts intended to fund certain non-qualified pension and deferred compensation arrangements included in non-operating expenses totaled $1 million in 2022, $12 million in 2021 and $5 million in 2020.
Amounts recognized in other comprehensive income (loss) in 2022 and 2021 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Pension Benefits | | Postretirement Medical Benefits |
| 2022 | | 2021 | | 2022 | | 2021 |
Net gain (loss) arising during the period | $ | 11,189 | | | $ | 42,039 | | | $ | 9,044 | | | $ | 2,391 | |
Amortization of net (gain) loss | 4,701 | | | 9,248 | | | 345 | | | 1,002 | |
Prior service credit (cost) arising during the period | 267 | | | 1,458 | | | — | | | — | |
Settlement (gain) loss | — | | | 12,285 | | | — | | | — | |
Amortization of prior service (credit) cost | 84 | | | 246 | | | — | | | — | |
Total | $ | 16,241 | | | $ | 65,276 | | | $ | 9,389 | | | $ | 3,393 | |
Amounts included in accumulated other comprehensive income (loss) as of December 30, 2022 and December 31, 2021, that had not yet been recognized as components of net periodic benefit cost, were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Pension Benefits | | Postretirement Medical Benefits |
| 2022 | | 2021 | | 2022 | | 2021 |
Prior service cost | $ | 1,668 | | | $ | 1,293 | | | $ | — | | | $ | — | |
Net gain (loss) | (55,084) | | | (70,995) | | | 1,891 | | | (7,498) | |
Net gain (loss) before income taxes | (53,416) | | | (69,702) | | | 1,891 | | | (7,498) | |
Income taxes | 12,207 | | | 15,443 | | | (416) | | | 1,650 | |
Net | $ | (41,209) | | | $ | (54,259) | | | $ | 1,475 | | | $ | (5,848) | |
Assumptions used to determine the Company’s benefit obligations are shown below:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Pension Benefits | | Postretirement Medical Benefits |
Weighted average assumptions | | 2022 | | 2021 | | 2022 | | 2021 |
U.S. Plans | | | | | | | | |
Discount rate | | 5.6 | % | | 3.0 | % | | 5.6 | % | | 2.9 | % |
Rate of compensation increase | | 2.7 | % | | 2.7 | % | | N/A | | N/A |
Non-U.S. Plans | | | | | | | | |
Discount rate | | 2.4 | % | | 0.4 | % | | N/A | | N/A |
Rate of compensation increase | | 1.8 | % | | 1.3 | % | | N/A | | N/A |
Assumptions used to determine the Company’s net periodic benefit cost are shown below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Pension Benefits | | Postretirement Medical Benefits |
Weighted average assumptions | | 2022 | | 2021 | | 2020 | | 2022 | | 2021 | | 2020 |
U.S. Plans | | | | | | | | | | | | |
Discount rate | | 3.0 | % | | 2.6 | % | | 3.5 | % | | 2.9 | % | | 2.6 | % | | 3.4 | % |
Rate of compensation increase | | 2.7 | % | | 2.7 | % | | 2.8 | % | | N/A | | N/A | | N/A |
Expected return on assets | | 6.3 | % | | 6.3 | % | | 6.8 | % | | N/A | | N/A | | N/A |
Non-U.S. Plans | | | | | | | | | | | | |
Discount rate | | 0.4 | % | | 0.4 | % | | 0.4 | % | | N/A | | N/A | | N/A |
Rate of compensation increase | | 1.3 | % | | 1.3 | % | | 1.3 | % | | N/A | | N/A | | N/A |
Expected return on assets | | 1.0 | % | | 1.0 | % | | 1.5 | % | | N/A | | N/A | | N/A |
Several sources of information are considered in determining the expected rate of return assumption, including the allocation of plan assets, the input of actuaries and professional investment advisers, and historical long-term returns. In setting the return assumption, the Company recognizes that historical returns are not always indicative of future returns and also considers the long-term nature of its pension obligations.
The Company’s U.S. retirement medical plan limits the annual cost increase that will be paid by the Company to 3 percent. In measuring the accumulated postretirement benefit obligation (APBO), the annual trend rate for health care costs was assumed to be 8.5 percent for 2023, decreasing each year to a constant rate of 4.5 percent for 2038 and thereafter, subject to the plan’s annual increase limitation.
The Company expects to contribute $1.9 million to its unfunded pension plans and $1.8 million to the postretirement medical plan in 2023. The Company will not be required to make contributions to the funded pension plan under minimum funding requirements for 2023. Estimated future benefit payments are as follows (in thousands):
| | | | | | | | | | | |
| Pension Benefits | | Postretirement Medical Benefits |
2023 | $ | 15,583 | | | $ | 1,763 | |
2024 | 17,035 | | | 1,748 | |
2025 | 16,406 | | | 1,735 | |
2026 | 18,585 | | | 1,715 | |
2027 | 20,116 | | | 1,699 | |
Years 2028-2032 | 107,755 | | | 8,136 | |
K. Commitments and Contingencies
Operating Lease Liabilities and Assets
The Company owns most of the assets used in its operations, but leases certain buildings and land, vehicles, office equipment and other rental assets. The Company determines if an arrangement is a lease at inception. All of the Company’s current lease arrangements are classified as operating leases. The Company historically has not entered into financing leases. Operating lease assets and obligations are recognized at the lease commencement date based on the present value of lease payments over the lease term. Lease expense is recognized by amortizing the amount recorded as an asset on a straight-line basis over the lease term.
In determining lease asset value, the Company considers fixed or variable payment terms, prepayments, incentives, and options to extend, terminate or purchase. Renewal, termination or purchase options affect the lease term used for determining lease asset value only if the option is reasonably certain to be exercised. The Company generally uses its incremental borrowing rate based on information available at the lease commencement date in determining the present value of lease payments.
Supplemental information related to the Company's lease activities is as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
Operating lease expense | $ | 12,307 | | | $ | 11,641 | |
Operating lease payments | 11,886 | | | 11,564 | |
Non-cash additions to operating lease assets | 8,859 | | | 1,631 | |
Additional information related to operating leases is as follows:
| | | | | | | | | | | |
| 2022 | | 2021 |
Weighted average remaining lease term (years) | 3.0 | | 5.0 |
Weighted average discount rate | 3.00 | % | | 2.24 | % |
Variable lease costs and short term lease costs were not significant for the twelve months ended December 30, 2022 and December 31, 2021.
As of December 30, 2022, future maturities of operating lease liabilities were as follows (in thousands):
| | | | | |
2023 | $ | 9,555 | |
2024 | 7,931 | |
2025 | 5,462 | |
2026 | 4,118 | |
2027 | 2,514 | |
Thereafter | 2,928 | |
Total lease payments | $ | 32,508 | |
Present value adjustment | (1,896) | |
Operating lease liabilities | $ | 30,612 | |
Other Commitments. The Company is committed to pay suppliers under the terms of open purchase orders issued in the normal course of business totaling approximately $230 million at December 30, 2022. The Company also has commitments with certain suppliers to purchase minimum quantities, and under the terms of certain agreements, the Company is committed for certain portions of the supplier’s inventory. The Company does not purchase, or commit to purchase, quantities in excess of normal usage or amounts that cannot be used within one year. The Company estimates that the maximum commitment amount under such agreements does not exceed $59 million.
The Company enters into contracts with vendors to receive services. Commitments under these service contracts with non-cancelable terms of more than one year totaled $4 million in 2023, $3 million in 2024, $3 million in 2025 and $2 million thereafter.
In addition, the Company could be obligated to perform under standby letters of credit totaling $6 million at December 30, 2022. The Company has also guaranteed the debt of its subsidiaries for up to $8 million. All debt of subsidiaries is reflected in the consolidated balance sheets.
Contingencies. The Company is party to various legal proceedings arising in the normal course of business. The Company is actively pursuing and defending these matters and has recorded an estimate of the probable costs where appropriate. Management does not expect that resolution of these matters will have a material adverse effect on the Company, although the ultimate outcome cannot be determined based on available information.